This conversation is part of our Wisdom in Books podcast. Every week we inspire your reading with an exclusive author interview or my takeaways from a consequential book on investing, business, or life. Stay tuned for a new release every Wednesday at 3:30pm ET.
I had the pleasure of speaking with Jeff Gramm about some of the fascinating takeaways from his book, Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism.
Dear Chairman has been described as “a grand story” and an “illuminating read” by the Wall Street Journal, “a revelation” by the Financial Times, and “an excellent read” by Andrew Ross Sorkin at the New York Times.
Jeff manages Bandera Partners, a value-oriented hedge fund based in New York City. He is an adjunct associate professor at Columbia Business School and has served on several public company boards.
The following transcript has been edited for space and clarity. (MOI Global members, access all features, including ways to follow up with Jeff.)
John Mihaljevic: What inspired you to write Dear Chairman?
Jeff Gramm: For about six or seven years, I taught a value investing class at Columbia Business School. As a part of that class, I collected activist shareholder letters to public companies, and I would give them to my students and use them for didactic purposes. At some point, I thought to myself there must be a book which collects these things. I looked around for one and there wasn’t, so I thought I could do it and decided to begin collecting the best ones I could find.
I wrote to Warren Buffett because I knew he had a famous but unpublished letter to American Express in the 1960s. I wrote to Ross Perot because I knew about his letter to GM. I tried to find the Benjamin Graham letter to Northern Pipeline. From there, I didn’t have time to write a whole book and do the work it would take, but just enough good things happened to push it along. I got a letter from Buffett and from Perot. Ultimately, I abandoned the idea of doing a compilation of letters and wrote a narrative history of corporate governance and shareholder activism built around those letters.
As with any project, the end result was a lot different from the plan, and it took incremental nudges to make it all happen. I certainly didn’t think I would ever write a narrative history book while running a fund. I had a lot of ideas that never came to fruition, so I feel very fortunate that this one did. So many different things could have derailed it, and if it had ever gone on the side burner, I would probably never have finished it. As it was, I had a very productive nine-month stretch and churned out that book.
John: We feel very fortunate as well because it’s not just an insightful but also an enjoyable read and a really instructive history of activism. Maybe we could start at the beginning with the Ben Graham letter. Perhaps not many people would know before reading the book that Graham had this in him. I think he’s viewed in a bit of a different light, but tell us about his letter.
Jeff: Actually, Ben Graham was very much an activist. He did a lot of engagement with boards and proxy fights. I knew about the Northern Pipeline case because there’s a whole chapter of it in his memoirs. When I set out to write the book, I even thought that maybe I could do a different one because he’s already written about Northern Pipeline, and I knew he had done one on Hawaiian Electric or something like that. He’d done a few proxy fights on overcapitalized insurance companies, but it’s exceptionally hard to find this historical financial information. Even finding the Ben Graham letter to Northern Pipeline was a huge ordeal – no one knew where it was.
That chapter does a nice job of launching the book because there’s always that opening chapter in value investing books about efficient markets and the fact that this stuff does work, and there are these cases of inefficiency. Joel Greenblatt’s book You Can Be A Stock Market Genius begins with a chapter saying that it works. I feel like for Dear Chairman, nothing is clearer in corporate governance than when you’re dealing with a company so overcapitalized that it’s trading for substantially less than the value of its cash holdings. It was a lovely way to highlight all of these basic governance and stewardship ideas and to be able to do it through Benjamin Graham, the father of value investing. It’s a fun case, right? He was very early in his career and found this situation in Northern Pipeline where he figured out that it had these liquid bond and cash holdings. He thought it was going to be a cinch to convince these guys to distribute them to shareholders, and he was very much mistaken.
John: I believe the Rockefeller Foundation had a fairly large stake in the company. How did that dynamic play out, and what was the outcome?
Jeff: Yes, it had 27%. When they broke apart Standard Oil, they formed eight different pipeline companies. They were all public, and the Rockefeller Foundation was the largest shareholder in each of them. The majority of the companies were extremely overcapitalized. At that point, the mid-1920s, the Rockefellers had the same philosophy as most investors of their day and many today have, “we’re not going to tell them what to do on a micro level. As stewards of this capital, we’re not going to force these guys to distribute cash or anything like that.” Ben Graham made a five-page eloquent plea that they should do it, and he waged a proxy battle. Once he won board representation, the existing board caved and paid out the cash. When that happened, the Rockefellers thought it was great, and they quickly leaned on all of the other pipeline companies to do the same thing.
John: Tell us a little about the tone of the Graham letter. Can it be compared to the activist letters of today, which are fairly combative?
Jeff: No, it was a very respectful letter, and so were the responses from the company. Graham had this notion of, “I will dabble in capital allocation, but I’m not going to tell you how to run your business.” At some point, I think he even said it would be inappropriate for him to provide operating input. We know that activism today has evolved to this point where you see activists complain about the menu items at a restaurant company, the quality of the French fries and stuff like that. Things have come a long way since then. This book highlights the whole evolution.
John: You mentioned the Buffett letter to American Express. I think that’s another instance where even Buffett followers didn’t necessarily know such a letter existed because whenever I’ve heard Buffett talk about American Express, I don’t think he brings up the letter. Tell us about that. How important was it to Buffett’s investment in American Express?
Jeff: He definitely talks about American Express as the turning point in his career. Both the Lowenstein book and the Schroeder book, The Snowball, highlight his investment in AMEX as the point where he began to see the value of a durable franchise versus just the cigar-butt investing he’d been doing. Buffett has written a lot of activist letters, and he did a lot of activism between 1955 and this American Express investment in 1964. At Columbia Business School, they have an archive of papers from Walter Schloss, who had a couple of Buffett’s angry letters to public companies. I know he has a lot of that stuff in his files in Omaha, just like the Ben Graham letter, complaining to overcapitalized companies. However, American Express was very different. He was on the side of management, opposing shareholders trying to get the company to take a shortcut to deal with a liability it was facing. The letter was all about there possibly being a short-term benefit to doing what these shareholders wanted, but it was going to come at a great cost to the company’s franchise value. It was also a nice exposition of Buffett’s evolution from deep, deep value cigar-butt investing to buying good businesses.
John: As you point out, he had written quite a few activist letters, as well as taken various measures to even gain control of companies that he felt weren’t allocating capital the right way. Do you think the situation with AMEX and the letter he wrote was not just a turning point in his approach to investing but also in his approach to dealing with management teams? Today, he is known as a friendly and supportive shareholder who voices any disagreements behind closed doors.
Jeff: I’m not sure. I think he prided himself on this letter. It was definitely a fabulous investment for him. I think the real turning point for him with not being hostile and being more of a cheerleader engager was the Dempster Mill company. He got on the board and was vilified in the local press for his efforts to cut costs and generate cash from those old dying assets. I think he learned the ugly side of activism and how people look down on it. It’s interesting. In the mid-1960s, when he began to walk away from cigar-butt investing, there were still ample opportunities to be very profitable doing what Walter Schloss did, and I think he simply got tired of it.
In one of the first years that I went to Berkshire Hathaway, I met Rick Guerin, who’s on the Daily Journal board. He was one of the superinvestors Buffett talked about in his paper The Superinvestors of Graham-and-Doddsville. Mr. Guerin was explaining how no one invested in public equities in the 1950s. All of the smart money and the sophisticated market participants invested in bonds. They had this little crew of guys – him, Charlie Munger, Walter Schloss, and Buffett – who would buy control of little companies, go on the board and get them to treat shareholders fairly. They all made a killing, and a lot of them retired. He quit doing it not that long after. I remember him saying, ” I thought Warren would get bored of it and would run for President one day.” I think Buffett found that he didn’t like being on board and didn’t particularly like being an activist. His new investing style was finding good businesses and growing companies like American Express and See’s Candies. It suited his personality.
John: Switching gears to Ross Perot, what’s the context of his letter to GM?
Jeff: The Perot story is my favorite in the book. Perot, who just passed away, was a legendary businessman. He founded EDS, a company that was one of the highfliers of the go-go stock market. John Brooks’ book, The Go-Go Years, begins with an anecdote about Ross Perot losing some tremendous amount of money in one day on paper because he built a huge fortune through this company. What ultimately happened is that GM, by the early 1980s, was struggling with competition from Japan and was beginning to stagnate, and it had a bureaucratic, frozen corporate culture.
The CEO, Roger Smith, had many faults, but he knew what was wrong with GM in some ways. He bought EDS with his idea of infusing old, tired GM with the energy and the entrepreneurship of Ross Perot. Through this deal, Perot became the largest shareholder. He went on the board of directors and quickly began to disagree with Roger Smith about some key directional issues at the company, ultimately becoming a dissident board member. Perot wrote a pretty hostile letter about Roger Smith’s proposed acquisition of Hughes Aircraft – that’s in the book, and it’s an unbelievably good letter. It’s in bullet points, and it attacks Roger Smith’s conduct in the board meetings and his management style. After the letter was sent, Roger Smith decided that he had to get Ross Perot off the board. GM ultimately paid Perot $750 million, buying back his stock at a huge premium to get him to walk away.
This was a major turning point in corporate governance because all big pensions fund investors in GM saw it happen. They knew the company was underperforming. It had a legendary businessman added to the board of directors, and all of a sudden, it squandered a huge amount of money to remove a guy that they thought was probably the best board member. These big institutions – CalPERS, TIAA-CREF, and the Wisconsin Investment Board – begun to get really frustrated with the climate in the 1980s. Hostile raids, greenmail, and other things happening in the market were disenfranchising long-term passive investors. Then the Ross Perot thing happened, and it drove them over the cliff. It made all these institutions become a lot more engaged and pay far more attention as owners and stewards. That has fostered the environment of hedge fund activism you see today. Today, the hedge fund activists are the guys who get all the headlines, but what really controls corporate governance is how these big passive institutions vote, and this changed after Ross Perot.
John: Would you describe the Perot situation as greenmail? It sounds like he didn’t go in with the intention of greenmailing them.
Jeff: It was a complicated thing because it was a special class of stock, and they were contractually allowed to buy him out at that price. It was not technically greenmail, but it basically was. There are people who complain that Perot was very sanctimonious, but he ultimately took this money. Perot said they’d done a buyout they were allowed to do, but if the shareholders stood for this, they were idiots. He challenged the shareholders to force GM not to do what it was going to do, and it went ahead with it. The shareholders ultimately allowed it to happen, but they very quickly realized that all of this bad stuff happened on their watch. There was a lot of institutional change at GM over the following three years, including the departure of Roger Smith as CEO, shareholders demanding that he not be chairman of the board or on the board at all, and the next CEO getting quickly fired. There were pretty big changes at the GM board and among their shareholders because of the aftershock of Perot.
John: You mentioned that what really matters is how the big passive institutions ultimately vote. Do you know the role of the proxy advisory services like ISS at the time? Any light you can shed on when they started to become more influential?
Jeff: They basically came out of the ashes of that era. They were founded by Robert Monks and Nell Minow, two governance gurus reacting to the same thing as everyone else in the 1980s, namely that governance had gotten terrible and the big shareholders had been complacent and allowed it to happen. I think ISS was founded 1983 or 1984, just around the time of GM. It grew quickly in importance and power. I talk about ISS a fair bit in my book and the dangers of a checklist style of valuation and corporate governance. When Warren Buffett was on the board of Coca-Cola, ISS famously recommended that shareholders not support him as a director because he owned Dairy Queen, so there was a conflict of interest because Dairy Queen was a customer of Coke. When you evaluate corporate governance by checklist, you will make some pretty perverse recommendations. In general, I think ISS does a pretty good job with contested elections. It has a robust team that looks at every proxy fight, and it knows all the players involved and all the shareholders, so I consider it valuable to the system.
John: Thanks for pointing out the Buffett Coke situation because it does highlight the downside of the checklist-style system. More recently, we saw it with the vote against Tom Gayner at one of the companies where he’s a board member.
Jeff: For smaller companies and non-contested elections, ISS still has its checklist. When I joined the Tandy board, they had put on a poison pill because I was buying up so much stock, and they wanted to prevent me from effectively getting control without paying a premium. I was up to 30%. They put the pill on and the structure of that pill, and it not being subject to a shareholder vote violated the ISS checklist, so it recommended a withhold vote for every other director but me. With non-contested elections, where ISS doesn’t have a bunch of brains looking at it and is just going on its best practices, it can recommend some pretty crazy stuff.
John: Let’s fast-forward to the Dan Loeb era. I remember that when he started putting out his letters, they were a shock to the system in terms of how they were written. Tell us about what that meant for the whole hedge fund activist movement.
Jeff: That was a fun chapter to write. In a way, it’s about the emergence of hedge fund activists. I talk specifically about Dan Loeb’s engagement with Star Gas, but then I also talk about Bob Chapman and a bunch of early trendsetters in hedge fund activism. Early hedge fund activism was pretty interesting because the industry was way smaller. It was very nichey, with a lot of investors without that much capital. A lot of that early activism was not buying a 5% stake and then trying to get the big institutions to support you. It was often just buying a 5% stake and trying to shame the company into doing the right thing. Because that was their tactic, they would frequently choose controlled entities.
Many of the Bob Chapman and even the early Dan Loeb activist situations were going after controlled companies, which is incredibly difficult to do. You can’t get them voted out, so the only tool at their disposal was to try to shame them or find discrepancies in their background that would force them to quit the board. They tried to use that tool as best as they could. Activizing against a controlled entity is a tough game to play. Ultimately, if the entrenched board doesn’t care about shareholders, you can only do so much with shame. Over time, the hedge fund industry matured. Guys like Dan Loeb became a lot more institutionalized, and their activism became a lot more buying 5% and getting support from big institutions. The chapter is about that evolution.
John: I guess the initial shock factor also wore off over time where the shame factor probably decreased over time.
Jeff: When you’re not going after small public companies controlled by bad people but larger public companies that maybe aren’t governed that well or need a new CEO or should be sold, you’re trying to win support from these big institutions. No one loves seeing people go after the CEO’s mother. If you’re trying to win support and votes, being a total jerk is not the way to do it. Interestingly, the only person who objected to my chapter on them was Dan Loeb. I think he didn’t like the idea of being memorialized in history as a hostile, pissy activist because he felt that was a very small part of his career.
John: The BKF Capital situation was the Warren Lichtenstein activist play, right?
Jeff: Yes. That’s one any deep value investor will remember. It had a big thread on the Value Investors Club. It was this unbelievable debacle where you had a public company in the money management business, and it owned a couple of hedge funds. This was the late 1990s-early 2000s. Who would better understand the profitability and the growth prospects of hedge funds than a bunch of activist hedge fund managers? All these activists got involved because they thought it was undervalued and a good business but was overpaying its people. Ultimately, they won the proxy fight, and then all the people at the hedge fund walked at the money management business. I can’t remember the exact numbers, but I think it went from $13 billion in assets under management to essentially zero in 18 months. The activists got support from the shareholders and won, but when they got onto the board, they just destroyed the company.
I try to explain in my book how we got to now and tackle broader business history issues, but it’s not a prescriptive book about activism. I’m not saying here’s how you do it, here’s why activism is bad, or here’s why activism is good. I try to make it very balanced, and I think BKF is a real case of how things can go wrong.
John: Since the book came out, have you followed any situations that you might consider putting in if you were in the midst of writing it?
